Citi may be broken up, under government influence

Sale of Smith Barney would jettison another business from Travelers deal

By

AlistairBarr

SAN FRANCISCO (MarketWatch) -- Some private investors have been calling for Citigroup Inc. to break itself up for years. Now, according to analysts, the government may be doing the job.

Citi
C, -0.05%
is in talks to sell a majority stake in its Smith Barney brokerage business to Morgan Stanley
MS, +0.96%
for roughly $2.5 billion, according to a Wall Street Journal report. The deal would be set up as a joint venture and would likely give Morgan Stanley an option to buy the rest of the unit later, reports say.

Citi shares slumped 17% to close at $5.60 as investors worried that such a deal favored Morgan Stanley over Citi. Morgan shares slipped 1.4% to $18.79.

If the transaction were to go through, it would mark another departure from the financial-services-supermarket business model that was consummated when Citi, headed by John Reed, and Travelers Group, run by Sandy Weill, agreed to merge in 1998.

Citi has already sold most of the insurance businesses that came with that groundbreaking deal, along with the money-management business. The only major unit left would be consumer finance, a category in which Citi operated before the merger, Ladenburg Thalmann analyst Dick Bove noted Monday.

Sudden departure

Even before the financial crisis hit in 2007, some investors were calling for Citi to be broken up, arguing the company had become too unwieldy to manage. The calls were rejected by executives at the company.

As recently as early December, Citi Chief Executive Vikram Pandit told analysts and investors that the company had the right business mix. The Smith Barney deal would be a sudden departure from that, suggesting government involvement, UBS analyst Glenn Schorr said Monday.

"That a month later such a transaction is even a possibility suggests to us that this move is at least partially being driven by the ownership presence of the U.S. government," Schorr wrote in a note to clients.

Citi may also sell its Mexican business, Banamex, Schorr and Bove noted.

"Technically, Citi hasn't been nationalized, but it feels increasingly like there are a few additional folks pulling the strings," Schorr added. "It sure seems like there's some real pressure on Citi to continue to shrink itself into a more manageable, smaller company."

News of a potential deal with Morgan Stanley broke Friday as former Treasury Secretary Robert Rubin resigned as senior counselor and director at Citi. See full story.

"Both actions suggest an end to the dream that John Reed and Sandy Weill had when they merged legacy Citicorp with legacy Travelers in an attempt to build a monolithic global financial company," Bove wrote in a note to investors.

When the credit crunch arrived, Citi was left with billions of dollars in exposure to collateralized debt obligations and other troubled mortgage-related assets. As losses mounted, it became one of the first banks to get a government investment from the Treasury's Troubled Asset Relief Program, receiving $25 billion.

But Citi shares continued to slump, forcing the government to invest another $20 billion in the bank and guarantee most of a $306 billion pool of troubled assets if losses exceed $29 billion. The Nov. 24 agreement also gave the government control over executive bonuses and put caps on dividends at Citi.

'A new order'

"Since, by some accounts, one might argue that the United States government is the largest investor in Citigroup with a 7.5% interest, any action of the magnitude being suggested here is likely to have been either approved of or stimulated by the banking regulators," Bove wrote.

Citi may emerge from such a government-inspired re-organization with three main businesses: consumer credit (including things like credit cards and retail banking); banking services for big corporations; and payment systems, the analyst said.

This may give investors clues to how regulators want the rest of the financial-services industry to change, Bove said.

During the credit boom, a shadow banking sector grew in which financial companies without access to deposits became major lenders. This has been in rapid decline since the subprime mortgage crisis erupted in 2007. See report on shadow banking.

Regulators may now want to re-emphasize the role of traditional banking at the center of the financial system, while separating capital markets activities from banking, Bove explained. They probably want to regulate the non-banking parts of the system too, he said.

"A new order is being put in place in the American banking industry," the analyst said.

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